U.S. banks looking to get in on a booming market for financing new-car sales have run into a formidable competitor: the auto manufacturers themselves.
Financing arms of car companies, including Toyota Motor, Honda Motor, and Ford Motor, made half of all new U.S. car loans in the first quarter, up from 37 percent a year earlier and the largest percentage of the market in four years, according to credit data firm Experian.
These companies also write the vast majority of leases, which contributed a record 26 percent of new car sales in the quarter, up from 23 percent last year and 20 percent in 2012.
The financing arms are providing subsidies from the manufacturers, lowering monthly payments and extending loan terms to make it easier for buyers to drive away in a shiny, new vehicle. As a result, major banks are increasingly moving into riskier parts of the market to make loans.
US Bancorp, for example, for the first time ever decided to start financing used cars, an area of the market that the automakers' finance companies have little interest in. It also started offering loans to less creditworthy borrowers.
And Wells Fargo has been leveraging off a nationwide deal with General Motors to provide loans subsidized by the No. 1 U.S. automaker. Wells sees this as a way to gain more of the used car loan business at GM dealerships.
The aggressive push by car companies is beginning to raise questions among industry analysts and consultants about whether it is sustainable.
If interest rates rise, the automakers could find the incentives too costly unless they are prepared to take a hit to profits—with any pullback in the deals being offered customers running the risk of hurting demand. And, if used car prices weaken, the financing units could be hit with losses on vehicles coming back from leases and repossessions.
The automakers financing companies are doing substantially more than they were just a year or two ago, said April Ancira, vice president in the San Antonio office of Ancira Motor, a Texas-based group with 11 dealerships selling GM, Nissan, Fiat, Chrysler, VW, and Ford cars.
"They're being very aggressive with incentives," Ancira said.
Pete Carey, vice president for sales at Toyota Financial Services, said incentives are playing a bigger role as automakers look to stand out in a crowded market where the basic quality of cars is uniformly good.
"We're at a point in the industry that we're spending as much as we've ever spent," Carey said.
The strategy is currently paying off in spades for automakers. All the major automakers posted healthy profits in the first quarter. U.S. car sales rebounded in May to an annualized rate of 16.8 million vehicles, against 15.6 million for all of last year. Sales were only 10.4 million in 2009 as the recession crushed demand.
Outstanding U.S. loans on new cars totaled $811 billion at the end of March, up 11.6 percent from a year earlier, according to Experian.
Fears of used-car glut
The automakers are in a position to offer the deals because their cost of borrowing has gone down as their balance sheets have improved and as bond investors have lined up to buy securities backed by loans and leases.
But they risk sweetening the deals so much that it starts to cut into their profit margins. In a few years time, as the leased vehicles are returned, the strategy could lead to a glut in the used-car market.
If a car turns out to be worth less at the end of a lease than projected, the finance company will take a loss on the lease, said Jim Ziegler, a consultant to car dealers. "It appears as a profit until they get the car back, Ziegler said.
Analysts at Moody's Investors Service said car resale values at the end of leases have so far tended to be higher than assumed, resulting in double-digit gains for finance companies and lease investors. But the gains have started to decelerate to single-digits now and they expect to see that downward pressure continue this year.
"There is still room for used car prices to decline before we see any losses," said Aron Bergman, of Moody's, but, he added, "the gains are going down."
The average monthly lease payment for the most-leased car in America, the Honda Civic, was $251 in the first quarter, according to Experian.
But when Jonathan Stierwald, a Minnesota resident, wanted to lease a car for his nephew, he found Mike Piazza Honda in Pennsylvania willing to lease him the car for three years for just $80 a month. He flew there to get the deal. The lease was financed by Honda's finance arm.
The details of the deal could not be determined. A salesman at the Langhorne, Pennsylvania, dealership, which is owned by Piazza, the former All-Star baseball catcher, said factors such as a high credit score and higher down-payment may have helped. Honda representative Steve Kinkade said the dealership could have added its own incentives on top of the company's promotions.
Honda, which was fifth in U.S. auto sales in the first five months of the year, increased its average subsidy per leased car by 26 percent to $1,476 in that period from a year earlier, according to Edmunds.com.
Kinkade said the company is pleased with how its finance unit has paced its leasing to drive sales without too many of the cars later coming onto the used car market and depressing prices.
Others are liberally using subsidies, too. Toyota subsidized 92 percent of its U.S. leases in its fiscal year ending in March, up from 82 percent the year before.
"We can get fairly aggressive with pricing or payments, depending on what we anticipate the used market to look like," Toyota's Carey said.
Auto industry analysts and consultants said they did not think the situation was getting out of hand just yet.
The average incentive per car sold so far this year was $2,918, up slightly from $2,825 a year earlier and just under 10 percent of the average transaction price, according to JD Power & Associates data.
Banks in used-car lots
Automaker finance arms are also offering loans at interest rates as low as zero percent. And, they are taking on more loans to borrowers with subprime credit ratings, according to data from Experian.
The length of loans is also increasing. Lenders granted one-in-four new car buyers more than six years to repay in the first quarter, up from one-in-five a year earlier, the figures show.
The average monthly payment on new car loans was $474 in the first quarter, only $15 more than a year earlier, even as the average amount financed rose by $964 to a record $27,612.
Unable to compete, some banks are in retreat.
Ally Financial, which was once GM's financing arm but is now on its own, increased its financing of used car purchases by 14 percent in the first quarter from a year earlier, but its new car lending declined so much that it made 6 percent fewer auto loans in total.
U.S. Bancorp estimated that used cars will eventually make up 40 percent of its auto loans after doing none in the past. Consumers with "nonprime" credit scores, defined as below 675, will account for 15 percent of U.S. Bancorp's portfolio, compared with none previously.
Not that the opportunity in the used car market isn't also large—in terms of numbers of vehicles sold the used car market is more than twice the size of the new-car market.
Tom Wolfe, executive vice president of consumer credit solutions at Wells Fargo, said its partnership with GM improves its ties with dealers and that for every subsidized new car loan it makes for GM at a dealer it will pick up three used-car loans. Wells Fargo is the largest U.S. used-car lender with a 7.1 percent market share, according to Experian.
Wolfe said customers who borrow to buy a used car so that they can get to and from work are good credit risks.